Too Big to Fail = Too Big to Exist

One of Dave Schuler’s favorite statements in recent months is that “Anything too big to fail is too big to exist.”  If we’re not going to allow them to shoulder the negative consequences of failure because we deem it too dangerous to society, then their very existence is too dangerous for society.   Ezra Klein makes a similar argument with slightly different logic:

The main lesson of all this is that society cannot permit the existence of private institutions that are too large to fail. And that’s not only because they might eventually fail and then we are on the hook for their liabilities. It’s also because the lesson of the bailouts — both the auto and banking bailouts — is that you desperately want to become too big to fail. You get better terms from the government. You’re protected from bankruptcy and insolvency. You have tremendous access to the halls of power. You get a seat at the bargaining table rather than before the bankruptcy judge. Reaching “too big to fail” status is like being kinged in checkers. The rules give you special powers and subsidies. Now that those advantages have been exposed, companies will have much more obvious incentives to chase size. Unless, of course, we stop them.

My only problem with this is that the probability of bad behavior on the part of government is being used to justify government having more power.   It’s similar to the argument that we can’t allow private individuals the freedom to smoke cigarettes, ride motorcycles without a helmet, or drive without a seatbelt because, after all, they could get hurt and turn to the welfare state.  It makes sense only if you assume a too powerful, too intrusive government.

Frankly, I’d rather just let Bank of America and AIG and others fail and let the chips fall where they may.

Cartoon: Lex Lowther

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James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. PD Shaw says:

    I think the corollary is being demonstrated. The companies too big to fail are also too big to save. I think the government has shown that it doesn’t have the institutional capability, let alone the judgment to run these companies. The most successful strategy has been to give failing businesses like Chrysler or National City to another business, now bigger.

  2. Dave Schuler says:

    The problem with letting “chips fall where they may” is that nobody knows what would happen. When you’ve been elected president or to the Senate the institutions that got you there look pretty good to you. If you can’t manage the transition, would the institutions that replace them look as good?

  3. odograph says:

    One good criticism of a size-cap is that 100 medium banks with the same business plan are as bad as 1 mega bank with that business plan.

    The sub-prime debacle (or for that matter the dot-com cycle) showed that businesses can follow bad plans en masse.

  4. odograph says:

    (Though I acknowledge that a size-cap would encourage diversity, while (my point) not guaranteeing it.)

  5. Cui bono?

    Whenever someone says something is too big to fail, ask them why they believe that? In every single case you are going to get a rent seeking answer in response, even if the responder doesn’t realize that is what they are asking for. Freedom includes the freedom to make bad decisions and the freedom to fail. I guess this is why freedom is becoming less popular with each passing election.

  6. One good criticism of a size-cap is that 100 medium banks with the same business plan are as bad as 1 mega bank with that business plan.

    This is one reason why Soviet five year plans always — always — failed to live up to expectations, because they required everyone to do things the same way. The failures in agriculture were spectacular when everyone had to plant according to one plan, whereas in the US every independent farmer made up his/her own mind as to what to plant and when to plant it. Sure some farmers made bad decisions or had bad luck with the weather, but overall the results were far superior to anything acheived through central planning.

    Now, with a foreknowledge of bureaucracies and process mania, tell me again how a single payer system for health insurance run by the government is going to be an improvement over what we have today.

  7. Drew says:

    odo –

    I’m not sure your comparison holds on two levels. One, do you know of 100 medium banks with the issues confronting JPM, BoA or Citi? Second, diversity of portfolios almost always carries the day.

    WRT dot.com. I have no issue with seventy-eleventy startups doing the me too. Its the foolish investors who really took the hit. And in America, you, as an investor, have the right to be stupid.

  8. just me says:

    The problem with letting “chips fall where they may” is that nobody knows what would happen.

    This is a good point, but I still don’t think the risk of what happens means the taxpayer should be picking up the tab to avoid finding out.

    Personally I am not a fan of TARP and all that has gone on since it passed. I think the auto bailout is ridiculous.

  9. Phil Smith says:

    It’s a moot point.

  10. odograph says:

    I wonder where Charles is coming from, after excellent examples of group-think and over-confidence in US firms. We demonstrably did not need SOVIETS to achieve that.

    Drew, we are up to 32 bank failures and counting.

    And sure, dot-com was somehow a less harmful catastrophe. Some of us even came out of it ahead.

    Maybe we need be more concerned with banks, and over-confident group-thing there, than elsewhere?

  11. Boyd says:

    The problem with letting “chips fall where they may” is that nobody knows what would happen.

    And as everyone knows, the best parts of the world today are those where we knew the outcome beforehand.

    Sarcasm aside, I’m stunned you would make such a statement, Dave. Oh, wait, I have another rejoinder:

    The problem with letting “chips fall where they may” is that nobody knows what would happen.

    Especially so, since we know exactly what’s going to happen with government intervention.

    Did somebody take over your body and post here in your place, Dave? Or maybe they just took over your mind.

  12. Tlaloc says:

    If we’re not going to allow them to shoulder the negative consequences of failure because we deem it too dangerous to society, then their very existence is too dangerous for society.

    Amen. I’ve supported cutting up Walmart on national security grounds for some time now. No one company should be allowed to exert that much power over the US economy.

    My only problem with this is that the probability of bad behavior on the part of government is being used to justify government to have more power.

    I don;t think that necessarily follows. If we choose to live in an organized society, and to date we have, then it is fair for us to recognize those things that are threats to that society and act to mitigate that threat. That may mean developing armed forces to discourage a militant enemy. It may mean environmental laws to prevent poisoning of our resources such that we our health is threatened. It might also mean recognizing internal groups with sufficient position and power to destroy the social system and moving to reduce their power or eject them from their positions.

    That argument has nothing to do with the government having too much power. It merely recognizes a shared desire and a step needed to keep that desire possible.

  13. PD Shaw says:

    Phil Smith, make sure you note this part of the story:

    Barring any appeal or further consideration of the sub rosa plan issue, the ruling likely means that ‘New Chrysler’ can emerge in 60 days ….

    Given the importance of the issue, an appeal was probably destined in any event, so a quick decision from the judge in favor of the plan doesn’t prejudice that process.

  14. Tlaloc says:

    One good criticism of a size-cap is that 100 medium banks with the same business plan are as bad as 1 mega bank with that business plan.

    Granted but
    a) it allows for diversity
    b) it allows for effects to come in waves, i.e. instead of the one company crashing at once you may see some subset of the 100 companies crash in succession, It’s easier to deal with a series of small hurts than one catastrophic impact. You may even be able to see the pattern emerge and head off the later collapses.
    c) it allows you to try different solutions. Take the first 10 and try x, the next 10 and try y, and so on and then see which solution best addressed the issue.

  15. Drew says:

    Odo –

    The last time I looked (admittedly awhile ago) the US has averaged about 150 failures a year since 1980.

    So 32 isn’t exactly a stunner. More importantly, the point is that issues at the dozen or so Citi’s of the US are inherently different from the Peoria Bank’s of the world because of what they do.

    Call me crazy, but I don’t thisnk Peoria Bank has a derivatives trading desk…….

  16. odograph says:

    Did you include the S&L crisis in your average years? 😉

    We are not at those records, but then again we don’t know what the picture would be like without a trillion or two in new funding facilities from the Fed, now do we?

    (for the alphabet soup of lending programs, see Understanding the Recent Changes to Federal Reserve Liquidity Provision)

  17. Brett says:

    My only potential problem is that there may be circumstances where the economic benefit of having those big companies may be greater than the occasional cost of saving their butts.

  18. Way too many threads here to comment on, but I have one question, does anyone really think more regulation is going to bring more diversity?

  19. Tlaloc says:

    Way too many threads here to comment on, but I have one question, does anyone really think more regulation is going to bring more diversity?

    Uh…yeah. The end point of unregulated capitalism is monopoly, which by definition is not very diverse.

  20. Nonsense. But thanks for playing.

    And then, of course, there’s the false dichotomy you offer of either no regulation or more regulation. More monopolies are created through government favors than unregulated capitalism, which is a figment of your imagination anyway.

  21. sam says:

    I’m not sure how one would go about imposing those size limits in our society without engaging in the kind of things that would make Charles and Drew, and most of us pretty damn uncomfortable. Interestingly, Plato confronted this limits issue (not, of course, that Athens had megacorporations as we do). If you recall your Republic, you’ll remember that the question was, What is Justice? Socrates says, Well, maybe we can see what Justice is, what a just man is, by constructing a just city. All agree, and he expounds his idea of the just city. Only, this first assay by Socrates results in a bucolic village–really a kind of Smallville in Attica. Well this won’t do Glaucon says (Glaucon is Plato’s older brother, btw; Plato was always giving his family jobs in the Diaglogues). We want you describe the just city in terms of wealth, and pleasure, and art, and theater, and athletic competitions…(i.e., a city like Athens). Oh, says Socrates, you want an account of the fevered city. And thus begins the discussion that leads to the highly structured polis overseen by the Guardians, etc.

    Now, we live in a fevered city, also. And just as Plato argued that only by the impostion of a severe and limiting structure could the unbounded desires and lusts of the citizens be kept in check (for the good of all, of course), I don’t think there is any way of imposing those size limits short of instituting a draconian regime. (After all, can anyone deny that bigness we’re talking about came about from a desire to accumulate more wealth?) And that would be a regime no one, if he or she thinks about it, would want to be subjected to.

  22. Grewgills says:

    I’m not sure how one would go about imposing those size limits in our society…

    Anti-trust laws?

  23. Drew says:

    odo –

    Yes, it included S&L’s. (Because that’s the only stat I could readily remember, not to nudge the statistic.) But also it was not a 30 year average where all the action was in the S&L debacle. The point still stands, 32 isn’t a head slapper. I just think the problems faced by Citi, JPM and BoA are fundamentally different than the First National Bank of Mayberry. The problem, of course, is that when measured by assets, about a half dozen bank dominate.

    Others –

    The defense of the mega-bank was for competitive reasons. (scale and reach) The notion was that America would fall behind as global mega-banks emerged, especilally in Japan. D Schuler, and others, have pointed out the downside to being too big.

    I think a serious debate (not political snark) about the pros and cons, and what to do about it, would be fascinating. I seem to recall a McKinsey guy wrote a book awhile back about this very issue. I’ll try to find it.

  24. Competitive destruction. Economies of scale lead to ever larger operations. However, at some point the sheer size of the institution limits the ability to act quickly and repsond to change, especially as the turf wars within the bureacracy start to heat up between the suddenly vested interests.

    Oh, and the federal government is so very much bigger than any corporation under discussion and it is a monopoly that is quite hostile to any competition whatsoever.

  25. sam, excellent comment.

  26. odograph says:

    Where I was coming from Drew, was rather than counting 30 as “low,” maybe we should ask how anyone can fail at all, with the discount window (DW), the Term Auction Facility (TAF), the Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF) all available.

  27. sam says:

    Humor break…The is for Drew and all the other duffers out there (me, too). I’m watching the Players, and the PGA gave George H.W. Bush an award. In a speech on the course, Mr. Bush said, “You know, when I was president, and my putt would come up short, they’d all say, ‘Oh that’s fine Mr. President, pick it up, pick it up.’ Now it’s ‘Hole it out, George, hole it out.’ It’s a lot different now, I can tell ya.” Heh.

  28. sam says:

    @Gregwillis

    I’m not sure how one would go about imposing those size limits in our society…

    Anti-trust laws?

    Anti-trust laws are designed to ensure competition. Size is not necessarily anti-competitive in itself (though in some cases it might be). And besides, none of the recipients of TARP funds, eg, were accused of anticompetitive behavior. Indeed, from what I’ve read, the big banks are fiercely competitive. Ditto the big auto companies. Anticompetitive behavior is not the problem, I think, in the modern era, or at least, as not a big a problem as it once was.

    And thanks, Charles.

  29. Tlaloc says:

    Competitive destruction. Economies of scale lead to ever larger operations. However, at some point the sheer size of the institution limits the ability to act quickly and repsond to change, especially as the turf wars within the bureacracy start to heat up between the suddenly vested interests.

    I am reminded of A bit of Fry and Laurie:

    “I don’t believe in market forces. I used to, of course, when I was a child, but like everybody else, when I grew older, I discovered it was all made up.”

    Your child like view of the world is sort of charming, charles, presuming of course you disabuse yourself of these fantasies before you reach a voting age.

  30. Tlaloc says:

    I’m not sure how one would go about imposing those size limits in our society without engaging in the kind of things that would make Charles and Drew, and most of us pretty damn uncomfortable.

    I’m not so sure there are that many of us left who care if people like charles and drew are comfortable. Their way was tried in the 80s and it was a disaster. It was tried again in the Bush year. Yep, disaster again.

    So really I don’t care if the people who didn’t learn either the first or the second times that their notions of economics are spectacularly wrong get discomforted by the adults fixing yet another of their messes. I’m guessing that for the time being there are enough people that agree with me on that.

  31. Steve Verdon says:

    I don;t think that necessarily follows. If we choose to live in an organized society, and to date we have, then it is fair for us to recognize those things that are threats to that society and act to mitigate that threat. That may mean developing armed forces to discourage a militant enemy. It may mean environmental laws to prevent poisoning of our resources such that we our health is threatened. It might also mean recognizing internal groups with sufficient position and power to destroy the social system and moving to reduce their power or eject them from their positions.

    That argument has nothing to do with the government having too much power. It merely recognizes a shared desire and a step needed to keep that desire possible.

    Missed that one by a mile Tlaloc. James isn’t making the point your are addressing above. He is arguing that these institutions are as big as they are due to government actions, now that we’ve seen that such action was bad we are going to give the government even more power to, ostensibly, fix it. Question is, can the government fix it, or will they make it worse.

    Don’t forget there is a rather insidious and incestuous relationship between government and high finance. If you look at the main people who’d be involved in the “fix” they all have some sort of connection to the finance sector. This goes for both parties. It isn’t a partisan problem, it is just a problem.

    Uh…yeah. The end point of unregulated capitalism is monopoly, which by definition is not very diverse.

    Complete and utter bollocks. The only case where you can get a monopoly via an unregulated market process is a natural monopoly and the criteria for that are rather stringent. Wal-Mart, for example, is not a natural monopoly. To get a monopoly where the conditions do not hold for a natural monopoly is via government fiat.

    Take a look at the NIRA during the recovery after the Great Depression (1934). That was an attempt to end “excessive competition” that was believed to be the cause of the Great Depression. Its goal was to cartelize (create a monopoly with seperate firms) to push up prices and wages. Net effect of such a policy would be to reduce output and increase unemployment. The higher prices are achieved by reducing output and the higher wages would induce people not in the labor force to return looking for work, but since output is being reduced there is less demand for labor, hence and excess supply and unemployment.

    So, no, more regulation does not have to promote diversity and competition does not promote monopoly. Competition is the antithesis of monopoly.

    Anti-trust laws are designed to ensure competition. Size is not necessarily anti-competitive in itself (though in some cases it might be).

    Quite correct. IANAL, but I recall there was a SCOTUS case where part of the decision is that merely being big is not sufficient in regards to triggering anti-trust laws and breaking a company up. If a firm has 100% of the market, but sets price such that Price = Marginal Cost that firm is acting exactly like a competitive firm, so there is no need to break it up.

    The problem arises in that when you have a natural monopoly Price = Marginal Cost is often not sufficient to cover total costs at that level of output. This is where the state intervenes and you get regulated monopolies. The current flavor of regulation is to try and preserve the price signal effect of the Price = Marginal Cost relationship, but scale up the price so that total costs are recovered.

  32. Tlaloc, do you ever find it necessary, or even helpful, to connect your responses to what other have said? Or do you just flip a coin to decide between an automatic gainsaying or reaching into your bag of hoary old chestnuts for a random thought?

  33. sam says:

    @Steve

    Don’t forget there is a rather insidious and incestuous relationship between government and high finance. If you look at the main people who’d be involved in the “fix” they all have some sort of connection to the finance sector. This goes for both parties. It isn’t a partisan problem, it is just a problem.

    I think maybe it is the problem that will always vex a democratic, captialist society. Money is power, and power gravitates to power. Goethe titled of one of his books Electivie Affinities, a now abandoned scientific term for the tendency of certain substances to bind with some substances in preference to others. Money and government have an elective affinity for each other. That’s the crux.

  34. Tlaloc says:

    Missed that one by a mile Tlaloc. James isn’t making the point your are addressing above. He is arguing that these institutions are as big as they are due to government actions

    I doubt it since that’s simply hogwash and I think Joyner’s smarter than to try and pass it off as an argument. GM is not big due to government intervention. Nor AIG. Fanny Mae and Freddy Mac, alright.

    Don’t forget there is a rather insidious and incestuous relationship between government and high finance.

    Absolutely which is why we rather need to take a hold of the current popular animosity to break the back of high finance since any other time the pols will shield them.

    Complete and utter bollocks. The only case where you can get a monopoly via an unregulated market process is a natural monopoly and the criteria for that are rather stringent.

    Oh, I thought we were talking about reality. You know that place where monopoly always occurs without government regulation and intervention? That place. Blue skies. You’ve heard of it I presume.

    Seriously you don’t expect anyone to believe that garbage, right? Monopolies occur anytime you let capitalism run un-shepherded because inevitably one competitor gains an advantage and leverages that advantage to crush his rivals. Standard Oil, Microsoft, Ma Bell, Walmart, and on and on and on. None of them brought about by government action by a market that was allowed to operate on autopilot.

  35. Tlaloc says:

    Tlaloc, do you ever find it necessary, or even helpful, to connect your responses to what other have said?

    Depends on how serious and thoughtful the thing I am replying to was. In your case you made an asinine statement devoid of merit and believed only by those with a fetishist love of economic theory above empirical fact. Therefore I felt free to simply give you the stinging glove of mockery and move on. At best it would snap you out of the inanity you had apparently internalized, perhaps allowing you to grow into a fully realized human being instead of a shallow caricature. At worst, well at least it didn’t validate said inanity.

    (Once again, the response matches the statement eliciting a response)

  36. Drew says:

    sam –

    Wo-wo-wo Them’s fight’n words. Duffer!? You are talkin’ to a former plus 1, and a current 4 handicapper…..

  37. Drew says:

    tlaloc –

    Markets do not work perfectly. That’s no great insight. But you went to a position that was more childish than those you were criticizing…….

  38. sam says:

    Sorry. There are duffers (moi), golfers (you), and aliens (T Woods). Shoulda not have assumed…

  39. Steve Verdon says:

    I doubt it since that’s simply hogwash and I think Joyner’s smarter than to try and pass it off as an argument. GM is not big due to government intervention. Nor AIG. Fanny Mae and Freddy Mac, alright.

    You are being too simplistic. It isn’t just whether or not it is government control/sponsorship as will Fannie and Freddie, but that there might be other laws, regulations, and such that provide effective barriers to entry allowing the firms to become dominant in their industry and prevent competitors from entering allowing for larger sized firms. Now maybe that is just a load of baloney, but you havne’t demonstrated that it is baloney.

    Absolutely which is why we rather need to take a hold of the current popular animosity to break the back of high finance since any other time the pols will shield them.

    You’ll fail utterly since it is the relationship between government and the financial sector, not just one sector by itself.

    Oh, I thought we were talking about reality. You know that place where monopoly always occurs without government regulation and intervention? That place. Blue skies. You’ve heard of it I presume.

    Name a non-governmental monopoly–i.e. has 100% control of the industry and sets prices without fear of competition. No, Microsoft doesn’t work. No Wal-Mart doesn’t work.

    Seriously you don’t expect anyone to believe that garbage, right? Monopolies occur anytime you let capitalism run un-shepherded because inevitably one competitor gains an advantage and leverages that advantage to crush his rivals.

    Limit pricing can work, but it is precarious in that market conditions change, so even if a firm can disuade entrants at time T, they can’t ensure lack of entry at time T+n. And that fear of entrants and competition limits the power of monopolies. Look at OPEC, a cartel that tries to act very much like a monopoly, they couldn’t maintain their grip.

    Standard Oil, Microsoft, Ma Bell, Walmart, and on and on and on. None of them brought about by government action by a market that was allowed to operate on autopilot.

    None of these, save for maybe Ma Bell, were actually monopolies. None have 100% of the market, price setting powers for their products are limited (e.g. Standard Oil made money off of railroads which likely have cost structure that make them natural monopolies–i.e. once it achieved a certain size Standard was able to take advantage of the railroads cost structure to expand its own business and limit entry of competitors). Further, it is doubtful that Standard’s monopoly position would have held for long as other companies were starting up that were based on the Standard Oil format–vertically integrated companies–that would offer a compeititve challenge to Standard and be somewhat immune to Standard’s tactics for forcing out competitiors.

    Walmart has significant competition from Costco, Target, and other stores as well. That one is just a case of “Big is bad” when it isn’t even clear Walmart is “too big to fail”.

    Microsoft also has competitors and it will be interesting to see how long it can maintain its position of dominance. However, in this case there is the element that Microsoft enjoys the effects of network externalities. The more people use Microsoft the more valuable it becomes since the system is obviously compatible with itself. However there are rivals and to the extent that these rivals can become compatible with Microsoft systems it weakens the advantage of network externalities at least in terms maintaining a dominant position.

    And in all cases it wasn’t too much competition that lead to monopolies, but too little.

  40. sam says:

    Microsoft also has competitors and it will be interesting to see how long it can maintain its position of dominance. However, in this case there is the element that Microsoft enjoys the effects of network externalities. The more people use Microsoft the more valuable it becomes ….

    Or, as someone once said, no IT manager was ever fired for buying Microsoft…